Business and Politics 2019; 21(2): 205–239
Saumya Prabhat and David M. Primo* Risky business: Do disclosure and shareholder approval of corporate political contributions affect firm performance?†
Abstract: The role of corporations in the U.S. political process has received increased scrutiny in the wake of the U.S. Supreme Court’s Citizens United deci- sion, leading to calls for greater regulation. In this paper, we analyze whether pol- icies mandating greater disclosure and shareholder approval of political contributionsreduceriskandincreasefirm value, as proponents of such rules claim. Specifically, we examine the Neill Committee Report (NCR), which led to the passage of the United Kingdom’s Political Parties, Elections, and Referendums Act 2000 mandating new disclosure and shareholder approval rules. We find that politically active firms did not benefit from the NCR in the days after its release and suffered a decline in value in the months and years that followed. Politically active firms also suffered an increase in risk, as proxied by stock return volatility, following the release of the NCR. We theorize that these findings are due to the reduced flexibility these rules impose on corporate strategy as well as the potential for these rules to facilitate political activism against corporations.
Keywords: corporate strategy, campaign finance, disclosure, corporate governance, nonmarket strategy doi:10.1017/bap.2018.24
*Corresponding Author: David M. Primo, Ani and Mark Gabrellian Professor and Associate Professor of Political Science and Business Administration, University of Rochester, Rochester, NY 14627; Tel.: 585-273-4779; Email: [email protected]. Saumya Prabhat. A note from Professor Primo: Saumya passed away after a revision was sub- mitted to this journal but prior to the completion of the final version. He will be missed. At the time of his death, Saumya worked for Freddie Mac. The views expressed in the paper do not reflect the views of Freddie Mac. The first draft of the paper was completed while Saumya was working at the Indian School of Business. † We thank Pat Akey, Shunlan Fang, Fabrizio Ferri, Ray La Raja, Hariom Manchiraju, John Matsusaka, and seminar/conference participants at ALEA, APSA, USC, UT Austin, and the MIT Asia Conference, for helpful comments. We thank Neil Moister and the Labour Research Department for providing us with political contributions data, and Andrew Dominic, Nicholas Foti, Nehali Jain, Jake Jares, Rochelle Sun, and Satish Sahoo for research assistance.
© V.K. Aggarwal 2018 and published under exclusive license to Cambridge University Press 206 Saumya Prabhat and David M. Primo
Introduction
In part due to the U.S. Supreme Court’s decision in Citizens United v. FEC, some politicians, interest groups, academics, and activist investors are pressuring firms whose stock is publicly traded in the United States to disclose all of their political spending and receive permission from shareholders before making such expendi- tures. The pressure for greater transparency and shareholder oversight has taken many forms, including legislation,1 disclosure ratings,2 shareholder resolutions,3 law- suits,4 and a petition for SEC regulation.5 Some proponents of a stricter regulatory regime view corporate political spending as risky, opaque, and harmful to share- holder value. According to this view, mandatory disclosure and shareholder approval of political spending will reduce risk and increase firm value. In this study, we provide evidence to the contrary and show that mandatory disclosure and shareholder approval policies could, in fact, increase return volatility and reduce firm value. There are three interrelated arguments for why corporate political spending harms firm value and increases volatility: activism, agency concerns, and moral hazard. Specifically, some proponents of a stricter regulatory regime view corpo- rate political spending as risky because (a) it draws unwanted attention from activ- ists, creating reputational, legal liability, and business strategy misalignment risks6 and a potential loss in value for the politically active firm, (b) managers may use the firm’s political spending to pursue a political agenda at odds with the interests of the firm, reducing firm value and potentially exposing the firm to activist criticism,7 and (c) it may lead to moral hazard, encouraging managers to take excessive risks in the belief that they will be protected by the government in the event that the bet goes bad.8 By constraining managers’ ability to use corporate funds for political purposes, disclosure and shareholder approval would seem to be policies that offer many benefits with few costs. Yet, there are several reasons to think that these policies will not be beneficial to shareholders. One, the release of proprietary information
1 See, for example, U.S. House of RepresentativesbillH.R.376,knownastheShareholder Protection Act of 2017 and U.S. Senate bill S.3348, known as the Accountable Capitalism Act, both introduced during the 115th Congress (2017–18). 2 See, for example, the CPA-Zicklin Index of Corporate Political Disclosure and Accountability, available at www.politicalaccountability.net. 3 Baloria et al. (n.d.). 4 Frankel (2013). 5 Committee on Disclosure of Corporate Political Spending (2011). 6 Conference Board (2012), 5. 7 Bebchuk and Jackson (2010); Aggarwal et al. (2012). 8 Kostovetsky (2015). Risky business 207 about a firm’s political strategy creates a roadmap for its competitors and hostile interest groups to attack the firm, creating the potential for negative media cover- age, reputational risks, and business disruption for the politically active firms. Second, managers fearful of reputational harms arising from such disclosures may spend less money on political activities due to concerns about the appearance of seeking “favors” from government and to prevent an attack by hostile interest groups, leading to an increased risk of unfavorable regulatory or legislative changes. Such disclosures may also reduce the marginal benefits of rent seeking if politicians become wary of appearing to grant favors to politically connected firms. This may benefit society as a whole, but it nonetheless may hurt share- holders (the focus of our paper), especially if not all firms cease rent seeking as a result of disclosure or shareholder approval. Third, shareholder approval could expose a publicly traded firm to greater reg- ulatory risk if it reduces the firm’s flexibility and agility in responding to a proposed regulatory change vis-à-vis privately held firms and other interest groups, or if the fear of losing a shareholder vote dissuades managers from spending money on political activities. More generally, firms use political spending to manage political risk and reduce their sensitivity to political uncertainty. To be sure, these dangers will be mitigated to the extent that firms can substi- tute other forms of political activity, such as increased lobbying, for campaign spending. But, as Albuquerque et al. (2017) show in the context of the U.S. case, campaign finance rules affect the strategic environment for corporations, and dif- ferent sorts of political activity are rarely perfect substitutes. Ultimately, the net effect of disclosure and approval of political spending on shareholder value and risk is an empirical question. In this paper, we utilize a quasi-natural experiment to examine whether greater shareholder oversight of political spending does, in fact, increase value, as proxied by Tobin’s Q and by abnormal returns, and reduce risk, as proxied by return volatility. Using the surprising Neill Committee Report (NCR) that led ulti- mately to the passage of the United Kingdom’s Political Parties, Elections and Referendums Act 2000 (PPERA), which mandated shareholder approval as well as greater and more centralized disclosure of political contributions, we imple- ment a differences-in-differences methodology and find little evidence that the report reduced volatility or increased value for politically active firms. In fact, our results point in the opposite direction. Using a differences-in- differences methodology combined with propensity score matching and quantile regressions, as well as an abnormal returns analysis around the date of the NCR’s release, we find no consistent evidence that shareholders benefitted from these mandates. Instead, we find that in the months after the NCR’s release, higher- risk politically active firms suffered an increase in risk, as proxied by stock price 208 Saumya Prabhat and David M. Primo volatility, hurting precisely the firms that such rules are thought to help. Moreover, this effect eventually filtered down to the entire distribution of politically active firms. Further, while there was no immediate effect of the NCR on returns, the longer-run effect was a decrease in firm value of 3–5 percent for firms that were contributing to UK political parties prior to its release. This paper contributes to the literature on political connections, contributions, and lobbying9 by providing evidence that calls into question the claim that man- datory disclosure and shareholder approval of corporate political spending reduce risk and increase firm value. Our results suggest that disclosure and shareholder approval may do more harm to firms than good, and we theorize that this is because these policies have the potential to short-circuit both offensive and defen- sive political strategies. Our paper also contributes to the literature on shareholder rights and corpo- rate governance. The existing literature has typically focused on shareholder activ- ism related to executive compensation;10 approval of board members and mergers;11 and the role of shareholder voting, proxy contests, institutional inves- tors, and proxy advisors.12 Our paper highlights the potential costs of mandated shareholder approval of political activity. Our evidence is consistent with Karpoff and Rice (1989), who suggest that managers facing frequent shareholder votes might spend a lot of time campaigning and end up compromising the firm’s long-term interests. Similarly, Yermack (2010) argues that voting on social issues can create negative publicity for a firm’s business practices, resulting in greater scrutiny by regulators and lawyers. Matsusaka and Ozbas (2017) show how share- holder approval rights have limited benefit (if any) for shareholder value, and how managers might react to shareholder proposal rights by moving firm policies away from those that pursue profit maximization. Our paper also relates to work by Baloria et al. (n.d.) and Werner (2017), who study shareholder activism on corporate political spending in the United States. Baloria et al. (n.d.) show that even if a shareholder proposal for political spending disclosure fails or is withdrawn, firms often shift their disclosure policies because of the activist activity, and investors react negatively to these changes. Werner (2017) uses a natural experiment—the inadvertent disclosure of corporate political
9 Milyo et al. (2000); Fisman (2001); Khwaja and Mian (2005); Faccio (2006); Faccio et al. (2006); Fan et al. (2007); Goldman et al. (2009); Yu and Yu (2011); Fisman et al. (2012); Kostovetsky (2015); Akey (2015). 10 Ertimur et al. (2011); Ng et al. (2011). 11 Burch et al. (2004); Arena and Ferris (2007). 12 Mulherin and Poulsen (1998); Gillan and Starks (2000); Yermack (2010); Matsusaka and Ozbas (2017). Risky business 209 spending—and finds that these disclosures negatively affected the returns of those firms that were already the target of shareholder resolutions regarding political spending disclosure, but increased the returns of other politically active firms (which presumably were not as vulnerable to activists). Finally, we contribute to the literature on corporate disclosure. The case for disclosure typically centers on information asymmetries and conflicts of interest between managers and investors.13 Our findings are in line with empirical papers that find negative effects of disclosure due to the transmission of proprietary infor- mation to competitors;14 increased litigation risk;15 and reputational and political costs arising from non-shareholders taking actions that adversely affect the firms.16 There are, as with any study, limits to the scope of our findings. First, the NCR and PPERA included other provisions, such as the establishment of an election commission and a cap on the amount a political party can spend in an election cycle. It is possible that these restrictions may have influenced the stock market or influenced contribution behavior, but these are less directly relevant to the corpora- tion than disclosure and shareholder approval. In addition, the UK’s Committee on Standards in Public Life singled out disclosure and shareholder approval in charac- terizing the PPERA as “the most fundamental overhaul of election rules funding since 1883” and argued that these two provisions were responsible for the decline in cor- porate giving in the 2000s.17 This gives us confidence that shareholder approval and disclosure are the most important aspects of the NCR and PPERA for corporations. However, our study’s design does not enable us to disentangle whether disclosure or shareholder approval is driving our findings, nor does it enable us to determine which of the mechanisms described earlier (e.g., reputational fears, activist threats) are driving the results. For instance, because we do not have access to data on lobbying by UK firms, we cannot assess which politically active firms were best positioned to deal with the changes wrought by the NCR and PPERA. Second, our results do not speak to other possible benefits and costs associ- ated with these policies that may influence their overall desirability for society. For instance, investors taken together may be better off with mandated disclosure if the policy prevents firms from seeking advantages in the political sector through rent seeking. A social welfare analysis in this paper would be complicated, however, as one would have to account for many other aspects of the law, includ- ingthatitaffected public but not private firms. Moreover, one would have to
13 Healy and Palepu (2001). 14 Darrough and Stoughton (1990). 15 Rogers and Van Buskirk (2009). 16 Watts and Zimmerman (1978); Li et al. (1997); Cormier and Magnan (1999). 17 Committee on Standards in Public Life (2010). 210 Saumya Prabhat and David M. Primo consider the effects on the electoral process and speech rights. Our focus is in this paper is squarely on the claims by corporate governance scholars and others that these policies benefit firms and shareholders. The paper proceeds as follows. First, we provide background information on the 1998 release of the NCR, which led to the passage of the PPERA in 2000. Then, we describe the construction of our dataset and our methodology, including how we handle the methodological challenges of checking for parallel trends, address- ing potential selection bias, and accounting for potential confounding events. Next, we present our findings, including several robustness checks, and conclude by dis- cussing the implications of our findings for corporate governance.
The Neill Committee Report and the Political Parties, Elections, and Referendums Act 2000
Before 2000, the campaign finance activities of political parties in the United Kingdom were lightly regulated, and parties were not required to report the sources of their funds. Even though political parties were not required to make their donor lists public, the UK’s Companies Act 1985 required covered companies to disclose political contributions over £200 in their annual Directors’ Report. The Companies Act also required corporations to disclose contribution amounts and recipient names.18 Fisher (1994) examined contributions to the Conservative Party in the year 1991–92 and found that of the top four thousand companies ranked by revenue, 242 made political contributions. The mean of those contribu- tions was £16,085, and the median was £5,000. In late 1997, Bernie Ecclestone donated £1 million to the Labour Party, alleg- edly to influence the proposed ban on tobacco advertising in Formula 1 racing. In response, the Labour-controlled government returned the money to Ecclestone and asked the Committee on Standards in Public Life (the Neill Committee) to study party financing activities.19 The committee proposed a set of strong reforms in British party financing activities in October 1998 in the Neill Committee Report. According to journalistic and scholarly accounts, some aspects of the report were leaked, but when the report was released, observers expressed surprise regarding how far it went.20 Fisher (2002,392)wrote,“Given the abject failure of previous attempts to reform party finance during the last
18 Adams and Hardwick (1998). 19 Fisher (2001). 20 The Daily Mail, 14 October 1998, “Keep All Referendums Neutral Says the ‘Sleazebuster’ Neill.” Paul Eastham, 8–9.; The Observer, 18 October 1998 “Tony Blair’sVeryBritishWayof Risky business 211 twenty-five years, the radicalism and comprehensiveness of the report caused genuine surprise.” Despite fears that Labour would be hurt by the new rules, leaders relented and the proposals eventually became part of the Political Parties, Elections and Referendums Act 2000. Fisher (2001) places the reforms of the PPERA into six categories: Electoral Commission, Donations, Campaign Spending, Third Parties, State Funding, and Referendums. The reforms include a cap on party spending and the creation of an electoral commission. Of the many provisions, the strengthening of disclosure requirements, as well as the requirement that publicly listed companies in the United Kingdom seek shareholder approval before making political contributions, stand out as the two most directly relevant to corporations. Indeed, at least two government reports issued after the PPERA’s enactment singled out one or both of these provisions as constraining corporations.21 On disclosure, the act expanded the definition of political contributions and provided a single source for the public to obtain contribution-related information for UK-incorporated firms in a standardized format—information that was already available, but scattered in the annual reports of the companies. In addition, a pub- licly listed firm now had to seek shareholder consent before exceeding £5,000 in political contributions in a given year.
The PPERA’s effect on contribution behavior: Suggestive evidence
Confounding events (news related to the 2001 national election and the UK fuel protests of 2000) near the enactment of the PPERA, and the fact that its passage was expected, make identification challenging. However, because the NCR was exogenous to corporate risk taking and the stringency of its recommendations were surprising, we can treat the NCR as a quasi-natural experiment and analyze its effects on the riskiness and value of UK-listed firms. First, however, weprovidesomesuggestiveevidenceregardingthePPERA’simpactonfirm behavior. Table 1 reports that of the ninety-five firms that contributed between 1992 and 1998 (the NCR was released in October 1998) and which are present in our data for atleastpartoftheperiod2001–6, only two continued to contribute after the
Revolution: Belated, Unbloody, Hesitant, Haphazard, but Unstoppable.” Andrew Rawnsley, 29; Fisher (2002). 21 Committee on Standards in Public Life (2010; 2011). 212 Saumya Prabhat and David M. Primo
Table 1: Contributions to political parties by publicly traded firms before the NCR and after the PPERA
Post-PPERA Contributor Post-PPERA Non-contributor
Pre-NCR Contributor 2 firms 93 firms Pre-NCR Non-contributor 10 firms 982 firms
Note: The sample consists of firms that are present in 1997 and for at least part of the period from 2001 to 2006. Because some firms are no longer in existence and/or in the Datastream database in the post-PPERA time period, the number of firms is smaller than in subsequent tables. The pre- NCR period is defined as 1992–98 and the post-PPERA period is defined as 2001–6.
PPERA, while ninety-three stopped contributing.22 These findings are consistent with those in Torres-Spelliscy (2012, 415–16), who finds that spending by twenty-eight UK firms that had previously given at least £50,000 to the parties dropped precipitously in the wake of PPERA. In another study, Torres-Spelliscy and Fogel (2011, 558–59) find that forty-nine companies that made political expen- ditures in the 1990s stopped giving entirely after 2000, and they suggest that the new rules “exerted pressure on listed [publicly traded] companies to refrain from funding political parties.” These authors also theorize that publicly traded firms may be disadvantaged by this law relative to privately held firms; they find that contributions by privately held companies “rose dramatically” inthewakeof PPERA relative to contributions by publicly traded firms (2011, 558–59). The Committee on Standards in Public Life in 2010 and 2011 also noted the impact of the PPERA on corporate behavior. In 2010, the committee wrote, “[d]onations from public companies have also apparently declined since the intro- duction in 2000 of the requirement for transparency and prior shareholder approval.”23 In 2011, it wrote, “Donations from public companies have been small since prior shareholder approval became a requirement in 2001.”24 This period also coincided with a transfer in control of government from the Conservatives to Labour. While the ratio of Labour to Conservative contributions of at least £5,000 by publicly traded firms increased after the shift, this is secondary to the reduction in the number of total donations overall by publicly traded
22 These results are striking because we are defining contributions in the post-PPERA period more broadly, following the legislative changes in the definition of a contribution. The PPERA expanded the definition of political organizations to include entities concerned with policy review and legal reform, and broadened the definition of a contribution somewhat (e.g., sponsor- ship of an annual political party dinner became categorized as a political contribution under the PPERA). 23 Torres-Spelliscy and Fogel (2011), quoted at 558. 24 Committee on Standards in Public Life (2011), 64. Risky business 213 companies.25 We leave for future research the question of how the PPERA changed the contribution behavior of specific firms and altered party finance. For our pur- poses, it is sufficient to establish the plausibility that the law did have such an effect. We turn now to the main analysis.
Data and methodology
The initial sample of publicly listed firms in the United Kingdom is drawn from Datastream for the period October 1996 to December 2002. Financial data and stock prices are also from Datastream. The Labour Research Department (LRD) generously provided us with data on contributions to UK political parties. We sup- plemented the LRD data by checking the annual reports of publicly listed firms in the United Kingdom. We use three measures of risk. The first is total risk, defined as the annualized volatility of daily stock returns. The second is systematic risk, defined as the annu- alized volatility of daily expected returns, estimated from the Fama-French three- factor model, which builds on the traditional capital asset pricing model (CAPM).26 Following Gregory et al. (2013), the factors used in this study are constructed using UK data. The third is idiosyncratic or firm-specific risk, defined as the annualized volatility of the residuals from the Fama-French three-factor model.
Measuring risk
Total risk (the variance of daily stock returns) for the stock of firm i in month T is computed using the following equation:
P (1) n ðR R Þ2 Total Risk ¼ t¼1 iTt iTavg : iT n 1
RiTt is the daily return of the stock on day t in month T, n is the number of return observations for the stock in month T, and RiTavg is the average of daily returns of the stock in month T. To compute systematic and idiosyncratic risk, firstweestimatetheFama- French three-factor model to predict expected returns:
25 Torres-Spelliscy and Fogel (2011). 26 Fama and French (1992; 1993). 214 Saumya Prabhat and David M. Primo